Detroit Defaults

Detroit Defaults

The City of Detroit has defaulted on a portion of its bonds, specifically on payments to unsecured creditors. Those who invested in bonds with dedicated revenue streams attached have been spared, for the moment, but the reorganization plan drawn up by emergency manager Kevyn Orr envisions a great deal of “shared sacrifice,” which apparently is what they’re calling it these days.

Typically, bondholders in the past have lost interest due them, but not their principals. That is not going to be the case in Detroit. Specifically, Detroit is expecting its creditors to take less than 10 cents on the dollar for having been foolish enough to lend money to the collection of misfits, miscreants, and criminals who govern that poor city. That’s step one. Step two is . . . borrowing more money, in order to pay for a program meant to rebuild the city’s institutions, reinvigorate its economy, and improve basic services. Who, I wonder, would be foolish enough to lend Detroit money hot on the heels of a default? The answer is likely to include the unwilling taxpayers of Michigan and those of the United States.

Detroit’s tax revenues are declining, and the city already is at or near the legal limit for the various taxes it imposes. It has a city income tax, but that will not do it a tremendous amount of good: In 2000, Detroit had 353,813 employed persons; today it has only 279,960. In 2000, it had an unemployment rate of 7.3 percent; today, it has an unemployment rate of 18.6 percent. It is a blighted and crime-ridden city — now the second-most-dangerous city in the country, according to the FBI, with nearby Flint leading the pack — which in addition to being a broader social problem is specifically a tax problem: Property values, and hence property-tax collections, are declining.

Kevyn Orr has also made it clear that reductions in pensions and health-care benefits for city retirees are a necessary part of any long-term solution for Detroit, which of course they must be: The city currently spends 40 percent of its revenue on so-called legacy costs, mostly retiree benefits.

That 40 percent number jumped out at me: Under current Congressional Budget Office projections, the federal government’s spending on its legacy costs (Social Security, Medicare, and interest on the debt) will be more than 50 percent of revenue in ten years. And, though the total impact will be small, you probably can add to those federal totals a little bit to account for the fact that Detroit plans to get out from under its health-care costs in part by dumping its liabilities onto Medicare and Obamacare. Thanks, Detroit!

As has been discussed at some length here, it is not entirely clear that Detroit, to say nothing of fiscally moribund states such as California or Illinois, legally can reduce its pensions and retiree benefits. In Michigan as in most states, those payments are protected by statute and/or constitutional provision. Orr is making it clear that he believes Detroit can reduce those payments — it simply does not have the money to make them and cannot raise sufficient funds through taxes. There are federal bankruptcy protections available to cities, though Detroit apparently plans to try to reorganize without a formal bankruptcy — Orr says there is a 50/50 chance that the city will not enter formal bankruptcy. But there are no such bankruptcy protections for states, and, unless the public-sector unions agree to a haircut for retirees (stop laughing) the pension mess probably is headed for the Supreme Court.

Detroit already is looking for federal assistance. For example, it is planning on spinning off the city water authority as a quasi-autonomous entity in the hopes that it will generate a nice revenue stream. It will be looking for federal loans to help make that happen. It will be looking for more federal funds to address its blight problems, to fix up the Coleman A. Young airport, to help fund services through grants, etc. It will be looking for money from the state of Michigan, too.

The problem is that the same political leadership that brought Detroit to this sorry pass remains in power. There probably is not much that can be done about that, and very little, short of mass seppuku in front of the Spirit of Detroit statue, that would convince me that they have mended their ways. Detroit cannot be trusted with its own money, it cannot be trusted with its creditors’ money, and it certainly cannot be trusted with federal taxpayers’ money.

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